Rising Interest Rates Must End Soon

Why now may be the most opportune time to buy bonds than at any time in the past two years.

The yield on the benchmark 10-year U.S. Treasury bond has risen by more than 84 percent from May to early September, one of the most violent and rapid increases on record. This spike has caused severe convulsions in the bond market, leading many investors to wonder how long the torment can last.

Video: U.S. Interest Rates

U.S. bonds will enter a secular bear market in the next 3-5 years

If history is our guide, the answer is that it may be over soon. Investors would be wise to remember that “soon” is a period of time, not a matter of degree. I make this point to be clear that while long-term interest rates still have room to increase in this historic bear market—maybe even significantly—now may be the most opportune time to purchase longer duration fixed-income securities in the past two years.

Largest Rise in 50 Years

On June 19, Ben Bernanke amplified signals that the Federal Reserve was preparing to taper bond purchases as part of his roadmap to unwind quantitative easing. His words, intended to calm markets, did just the opposite, spurring an unprecedented rise in rates. Rates began to move sharply higher in early May when the Fed turned hawkish and really took off after Bernanke’s comments.

The increase in U.S. Treasury yields of more than 115 percent since their bottom in July 2012 is greater on a percentage basis than any cyclical increase from trough to peak in the past 50 years. Previously, the largest such increase was 94 percent between December 2008 and April 2010. With history as our guide, we are now only days from the average length of such bear markets. The average time from trough to peak is 423 days. Now as Fed policymakers meet to discuss tapering asset purchases, it has been 420 days since rates last bottomed in July 2012.

Once rates peak, the average decline of the previous 16 interest rate cycles is 35 percent. That means, if 3 percent was the top of the current interest rate cycle we could expect rates to fall below 2 percent before another meaningful sell-off. Similarly, if rates continue to rise and top out at 3.5 percent, the trough could be 2.25 percent if averages hold. Whether rates on 10-year Treasury notes continue to rise from here or not, this could be a relatively good entry point to purchase long-duration bonds.

Buying Opportunity Near

The reality of how badly higher interest rates are hurting the economy is slowly becoming apparent and may soon prompt a reversal of fortune for bond investors.

So, what should an investor do? Now may be the time to consider adding to fixed-income assets, especially longer-duration bonds. Given the strong, negative sentiment, history tells us that a buying opportunity cannot be far away. While there is additional downside risk, no one can pick a top or bottom in markets with complete precision. But if history is any indication, 10-year rates may be heading back to 2.25 percent or lower, meaning the bet may pay off.

Why should interest rates decline? Since the Fed turned hawkish in May, higher interest rates have sent mortgage rates skyward. The abrupt rise in mortgage rates is having a material impact on housing activity. With mortgage applications declining, the critical tailwind of housing in the current expansion may soon become a headwind. More than half of all economic growth since last year came from housing-related activity.

Additionally, aggregate wages have begun to stagnate, leading to poor retail sales with autos and home suppliers being the sole bright spots. Without the wealth effect from housing to fuel consumption, it will be hard for the economy to overcome increasing challenges associated with the contracting fiscal reality.

It is safe to say that if rates move significantly over 3 percent it would be devastating for an already struggling American economy, prompting policymakers and investors to realize the growth the Fed hoped for is nothing more than a mirage.

Adding impetus for rates to move lower will be fiscal developments that should translate into lower-than-expected new U.S. Treasury debt issuance. The U.S. federal budget is shrinking, and tax receipts in 2014 are expected to rise thanks to higher taxes and strong capital gains receipts following strong 2013 stock market gains, thus reducing the supply of government debt.

Could recent market convulsions have been avoided? The simple answer is yes.

Dr. Bernanke’s expected January 2014 departure as chairman after eight years overseeing unprecedented growth of the Fed’s balance sheet may have left him with an urgent desire to show an exit strategy. Were it not for his impending exit, I suspect he would have otherwise let the economic data unfold for another three or six months before considering tapering.

Investment Implications

There has been much talk in recent months of the end of the 30-year bull market in bonds, but the coming bear market likely remains several years away. I believe rates will stay low and hover in a trading pattern for the next three to five years, similar to the 1940s, the period most analogous to today. During the 1940s and early 1950s, interest rates remained artificially low and oscillated between bear and bull markets for nine years. If I am correct, U.S. bond investors should expect yields to similarly remain low for the foreseeable future, but volatility like that seen this year could become a more regular occurrence.

In the near-term, if these dynamics play out as I expect, investors might begin planning to add longer duration, high-quality assets such as investment-grade corporate bonds to their portfolios. If rates peak in the near-term and reverse course, these assets, in particular, will be the primary beneficiaries.

As we move through the turbulence of tapering and look at the fundamental factors on the horizon, investors must have their antennae up to monitor the timing of these changing dynamics. While I see relief from rising rates soon, now is a time for bond investors to have patience, a watchful eye, and a strong resolve.

This year, equities have stolen the spotlight with strong returns, but are now badly in need of consolidation. Meanwhile, fixed-income investors seem overwhelmed with fatigue and have begun to throw in the towel after a discouraging year marked by poor performance and negative returns. This may just be the time to dust off this unloved asset class and consider history. Now may be the best time to buy bonds in years.

Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.

This is not an offer to sell nor a solicitation of an offer to buy the securities herein. Only a Guggenheim Credit Income Fund 2019 (GCIF 2019) prospectus makes such an offer. This material is authorized only when it is accompanied or preceded by a GCIF 2019 prospectus. Neither the SEC nor the Attorney General of the State of New York nor any other state regulator has passed on or endorsed the merits of this offering. Any representation to the contrary is a criminal offense. Securities are offered through Guggenheim Funds Distributors, LLC, member of FINRA/SIPC, as Dealer Manager.

This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.

By choosing an option below, the next time you return to the site, your home page will automatically
be set to this site. You can change your preference at any time.

Institutional Investor
Advisor
Individual Investor

We have saved your site preference as Institutional Investors. To change this, update your preferences.

United States Important Legal Information

By confirming below that you are an Institutional Investor, you will gain access to information on this website (the “Website”) that is intended exclusively for Institutional Investors and, as such, the information should not be relied upon by individual investors. This Website and any product, content, information, tools or services provided or available through the Website (collectively, the “Services”) are provided to Institutional Investors for informational purposes only and do not constitute a recommendation to buy or sell any security or fund interest. Nothing on the Website shall be considered a solicitation for the offering of any investment product or service to any person in any jurisdiction where such solicitation or offering may not lawfully be made. By accessing this Website, you expressly acknowledge and agree that the Website and the Services provided on or through the Website are provided on an as is/as available basis, and except as partnered by law, neither Guggenheim Investments and it parents, subsidiaries and affiliates nor any third party has any responsibility to maintain the website or the Services offered on or through the Website or to supply corrections or updates for the same. You understand that the information provided on this Website is not intended to provide, and should not be relied upon for, tax, legal, accounting or investment advice. You also agree that the terms provided herein with respect to the access and use of the Website are supplemental to and shall not void or modify the Terms of Use in effect for the Website. The information on this Website is solely intended for use by Institutional Investors as defined below: banks, savings and loan associations, insurance companies, and registered investment companies; registered investment advisers; individual investors and other entities with total assets of at least $50 million; governmental entities; employee benefit (retirement) plans, or multiple employee benefit plans offered to employees of the same employer, that in the aggregate have at least 100 participants, but does not include any participant of such plans; member firms or registered person of such a member; or person(s) acting solely on behalf of any such Institutional Investor.

By clicking the "I confirm" information link the user agrees that: “I have read the terms detailed and confirm that I am an Institutional Investor and that I wish to proceed.”